The dual nature of public goods and congestion: the role of fiscal policy revisited

The dual nature of public goods and congestion: the role of fiscal policy revisited

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Article ID: iaor201112001
Volume: 44
Issue: 4
Start Page Number: 1471
End Page Number: 1496
Publication Date: Nov 2011
Journal: Canadian Journal of Economics/Revue canadienne d'conomique
Authors: ,
Keywords: government, finance & banking
Abstract:

The role of fiscal policy is examined when public goods provide both productive and utility services. In the presence of congestion, the consumption tax is shown to be distortionary. Optimal fiscal policy involves using consumption‐based instruments in conjunction with the income tax. An income tax‐financed increase in government spending dominates both lump‐sum and consumption tax‐financing. Replacing the lump‐sum tax with an income tax to finance a given level of spending dominates introducing an equivalent consumption tax. These results contrast sharply with the literature, where the consumption tax is generally viewed as the least distortionary source of public finance.

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